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The UK and most of the world's economies are increasingly unsustainable, unfair and unstable. It is not even making us any happier – many of the richest countries in the world do not have the highest wellbeing.

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Behavioural economics

What would economic theory look like if we took human behaviour as our starting point? Neoclassical economists have long assumed that human beings are make rational choices in their own interest. Behavioural economics undercuts these assumptions to reveal how we really are.

September 22, 2005 // Written by:

Hetan Shah,Emma Dawney

Standard neoclassical economic analysis assumes that humans are rational
and behave in a way to maximise their individual self-interest. While this ‘rational
man’ assumption yields a powerful tool for analysis, it has many shortfalls that can
lead to unrealistic economic analysis and policy-making. This Briefing distils many
concepts from behavioural economics and psychology down to seven key
principles, which highlight the main shortfalls in the neoclassical model of human
behaviour.

The seven principles:

Other people’s behaviour matters: people do many things by observing
others and copying; people are encouraged to continue to do things when they
feel other people approve of their behaviour.

Habits are important: people do many things without consciously thinking
about them. These habits are hard to change – even though people might want
to change their behaviour, it is not easy for them.

People are motivated to ‘do the right thing’: there are cases where money is
de-motivating as it undermines people’s intrinsic motivation, for example, you
would quickly stop inviting friends to dinner if they insisted on paying you.

People’s self-expectations influence how they behave: they want their
actions to be in line with their values and their commitments.

People are loss-averse and hang on to what they consider ‘theirs’.

People are bad at computation when making decisions: they put undue
weight on recent events and too little on far-off ones; they cannot calculate
probabilities well and worry too much about unlikely events; and they are
strongly influenced by how the problem/information is presented to them.

People need to feel involved and effective to make a change: just giving
people the incentives and information is not necessarily enough.

Our aim is to change the analytical framework for policy as well as to maximise the impact of policy interventions. We also hope to reduce unintended outcomes arising from making decisions based solely on a neoclassical economic analysis.

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